MG 443: INDUSTRIAL

SAFETY AND
MAINTENANCE

LESSON 5: OPTIMAL
REPLACEMENT DECISIONS
 Introduction
 Replacement problems are of two types:
 deterministic
 probabilistic
 During replacement decisions the interested is
in the sequence of times at which the
replacement actions should take place.
 Any sequence of times is a replacement policy,
but the interested is in determining the optimal
replacement policies
Case of equipment with "infinite"
lifetime
 Assumptions in the models are presented
here:
 the equipment can be used for long lengths of
time;
 probabilistic problems have only two possible
conditions (good and failed)
 replacement actions return the facility to the new
condition
 for preventive replacement actions:
 total cost of the replacement must be greater after failure
than before
 the failure rate of the facility must be increasing
Case of equipment with "infinite"
lifetime
 Overhaul and repair can be considered as
replacement provided they return the equipment
to the as “new condition” – “AGAN Principle”
 The problem is to determine the optimal interval
between replacement after having noted that:
 deterioration of equipment increases operating costs
 replacing deteriorating parts reduces operating
costs
 replacements cost money in terms of materials and
wages and increase with replacement frequency
Case of equipment with "infinite" lifetime
  there is a trade off between operating and
replacement costs
 And there is an optimal replacement frequency
per specified period below which operating
costs exceed replacement costs and above
which the opposite happens
 The balance between operating and
replacement costs can easily be obtained
through determination of an optimal number of
replacements within a given study period
Case of equipment with "infinite"
lifetime
 Consider [0, T] in which the policy is to perform Nr equally
spaced replacements at intervals of tr.
 Cop(t) is the operating cost per unit time at time t after a
replacement, and Cr is the cost of a replacement.
 The aim here is to find the optimal interval between
replacements such that the overall costs are minimised.
tr

0 1 2 3 Nr T
Case of equipment with "infinite" lifetime
 Let the total cost Ctot(t), to be a summation of all
costs from the start to the end of planning
 To get the total replacement costs within [0, T], the
unit cost per replacement Cr will be multiplied by the
number of replacements Nr
CR = Nr * C r
 The total operating costs within [0, T] is equivalent
to operating cost for each interval between
replacements multiplied by the number of intervals
in period [0, T]
Nr 1
Cop ( tot )   Cop(tr )i
i 1
Case of equipment with "infinite" lifetime
 If it is assumed that tr is an infinitesimal
interval (i.e. limit tr0), then equation can
further be estimated as:
tr
Cop ( tot )   Nr  1 Copt  dt 5.1
0
Case of equipment with "infinite" lifetime
 The total cost within the same planning
interval [0, T] is given by the summation
of replacement and operating costs
tr
Ctot (t )  NrCr   Nr  1  Cop(t ) dt 5.2
0

Note that (Nr + 1)tr = T, therefore Nr = T/ tr - 1, and the

equation above can be rewritten as follows:
T T t r

Ctot (t )  Cr  Cr   Cop(t ) dt 5.3

tr tr 0
Case of equipment with "infinite" lifetime
 Cop(t) includes the cost of lost production, the cost
of reworking faulty work piece, the cost of
discarding or modification of the work piece and
other breakdown associated costs

Cop(t )  VWsc  Cbr  * ABtu   PNpq * Cre t 5.4

VWsc average value of work pieces on operating equipment

Cbr breakdown and breakdown associated costs
ABtu number of accidental breakdowns per unit time
PNpq amount of poor quality products produced by the equipment
per unit time
C reprocessing costs
Case of equipment with "infinite"
lifetime
 By substituting eq. 5.4 in 5.3 and solving the
integral part of 5.3, the resulting equation is
depicted as
TCr T
Ctot (t )   Cr  * VWsc  Cbr  * ABtu   PNpq * Cre tr
tr 2 5.5
Eq. 5.5 represents the total cost as a function of tr.
To determine the optimal value of tr, which will make the
total cost Ctot(t) minimum, differentiate eq. 5.5 with respect
to tr and the resulting expression set to zero
 TCr T
C' tot (t )  2  * VWsc  Cbr  * ABtu   PNpq * Cre 
tr 2 5.6
Case of equipment with "infinite"
lifetime
 Equating equation (5.6) to zero and simplifying
the expression, it can be shown that:
2Cr
tr 
VWsc  Cbr  * ABtu   PNpq * Cre 
The expression should then be evaluated for maximum
and minimum points by taking second derivative of 5.5

T VWsc  Cbr  * ABtu   PNpq  Cre 

3

C' tot (t ) 
4Cr 2
 Case of equipment with "infinite"
lifetime
 The total cost per unit time C(tr), for replacement
at time tr, is:
C(tr) = total cost in interval [0,tr]/ length of
interval
 The total cost in interval = cost of operating +
cost of replacement
tr
=  C(t)dt +
0
Cr

tr
1
 C( t r ) = [  C(t)dt + C r ]
tr 0
Case of equipment with "infinite"
lifetime
 This is a model of the problem relating replacement
interval tr to the total cost per unit time C(tr)
 In the present modeling effort, the time it takes to
make a replacement is omitted, which could be
included as follows:
 one replacement cycle time = operation time +
replacement time
tr

 C(t)dt + Cr
C( t r ) = 0

tr + t R
Maximization of Discounted Benefits
 Assumptions
 replacement is with an identical
equipment, i.e, one with similar
costs/benefits behavior
 equipment is operated over long period
of time
 replacement is based on maximum
discounted benefits
Maximization of Discounted Benefits
 Factors:
 b(t) net benefit obtained from the
equipment at time t
 (revenue at t) - (operating costs at t), b(t) will
most likely decrease with t
 c(t) net cost of replacing equipment of
age t
 purchase cost
 installation cost
 lost production
 less the salvage value of the used equipment
Maximization of Discounted Benefits
 Factors:
 i = the relevant interest rate;
 Tr = time required to replace the equipment
 tr = age of the equipment when replacement
occurs
 tr+Tr = the replacement cycle, i.e., the time from
the finish of one replacement action to the next.
During tr operating costs increase while benefits
decrease
 B(tr) = the total discounted net benefits derived
from operating the equipment for periods of
length tr, over a long time
Maximization of Discounted Benefits
 The period over which replacements
will occur will be taken as infinity,
although in practice this will not be the
case
 The objective is to determine the
optimum interval between
replacements such that the total
discounted net benefits derived from
operating the equipment over a long
period of time are maximized
 Maximization of Discounted Benefits
If we consider the nth cycle of operation, then:
the discounted benefits over the cycle
(discounting to the beginning of this cycle):
tr
= 0
b(t) e dt
-it

where e-it is a discount factor for the continuous

case. and the discounted replacement cost is:

= c( t r ) e -itr
Maximization of Discounted Benefits
Hence:
tr
( +
Bn t r T r ) =  e
b(t)
0
-it
dt - c( )
tr e
-it r

n = 1,2, 3, ...
Bn(tr + Tr) must be discounted back to the start
of the first period

Bn ( t r + T r ) e
-i(n-1)t r + T r
 Maximization of Discounted Benefits
if we denote (tr + Tr) by T, the total discounted net
benefit (i.e. for all cycles), over a long period of time,
with replacement at age tr, is:
-iT -i(n-1)(T)
B( t r ) = B1 (T) + B 2 (T)e + ...+ Bn (T)e + ...

Note that B1(T) = B2(T) = .... = Bn(T). Therefore we can

replace Bi's with B in the above equation. The result
is a geometrical progression to infinite which gives:
B(T)
B( t r ) =
1 - e-i(T)
Maximization of Discounted Benefits
and if we replaced B(T) with the expansion for
Bn(tr + Tr) we obtain

tr

 bt e dt  C tr e
 it itr

Btr   0
 i tr  Tr 
1 e
 Maximization of Discounted Benefits
 Procedure for obtaining a solution
 Establish b(t) on the basis of historical data e.g. b(t)
= a + b e-kt per year where a, b and k are constants
 Determine Tr
 Establish the relevant interest rate i.
 Substitute all of the above in the equation for B(tr)
and complete the integration.
 evaluate B(tr) for various values of tr; plot and
observe the pattern to see whether there is a
maximum for B(tr) and indicate when it occurs i.e.
the tr corresponding to the max B.
 Minimization of Total Cost
 Calculating the optimal replacement
interval for capital equipment while
minimizing total cost
 This problem is similar to the previous one
except that:
 the objective is to determine the replacement
interval that minimizes the total cost of
maintenance
 the trend in cost is taken to be discrete,
rather than continuous.
 Minimization of Total Cost
 Variables:
 A = Acquisition cost of the capital equipment
 Ci = Cost of maintenance in the ith period
 Si = Salvage value of the equipment at the end of the
ith period of operation i = 1, 2, ...., n
 r = the discount rate = 1 / ( 1 + i)
 N = the age in periods of the equipment when
replaced
 C(n)= the total discounted cost of maintaining
and replacing the equipment with replacements
occurring at intervals of n periods
 Minimization of Total Cost
 a cycle is divided into n discrete periods (e.g.
years) and it starts from just when a facility is
new to when it is replaced
 The total cost in the first cycle (leading to the
first replacement):

C1n   C1r  C 2 r  ...  Cnr  Ar  Snr

2 n n n

n
C1 (n) = C r + r
t=1
i
i n
(A - S n )
 Minimization of Total Cost
The total cost in the second cycle, discounted to
the start of the second cycle is
n
C 2 (n) = C r + r
t=1
i
i n
(A - S n )

The total discounted cost, when discounting is

taken to the start of operations, i.e., at time t = 0, is

C(n) = C 1 (n) + C 2 (n) r n +...+ C n (n) r (n -1)n

 Minimization of Total Cost
Since C1(n) = C2(n) = C3(n) = .... = Cn(n), we have
a geometric progression which gives, over an
infinite period
n

C 1 (n)
 C i r r (A - S n )
i=1
+in

C(n) = =
1-r n
1-r n
 Minimization of Total Cost
 Solution procedure:
 Establish A, the acquisition cost. Assume it is the
same for all the cycles
 Estimate maintenance costs per year for several
years in the future
 Establish the relevant discount rate r
 Estimate the resale value for several years in the
future
 Evaluate the expression for C(n) for different
values of n. Start with n=1 up to n = several years
approximately the age of the typical old machine
 Select the n* giving the minimum value of C(n).
Minimization of Total Cost
Nota bene: Basic assumptions in using
this model are:
 the acquisition cost has been assumed
to be constant.
 trends in maintenance costs are the
same after each replacements.
 Furthermore, we do not always replace
with new equipment
Technological Improvements
 Calculation of the optimal replacement
policy for capital equipment based on
technological improvements
 Improvements can be with respect to:
decreased maintenance and operating
costs; increased throughput; increased
quality of output
 Technological Improvements
 Variables:
 n = number of operating periods during which equipment
will be required
 CpiI = maintenance cost of the present equipment in the ith
period from now, payable at i=1,2,…,n
 Sp,i = the resale value of the present equipment at the end
of the ith period from now
 Ct,j = maintenance cost of the technologically improved
equipment in the jth period after its installation and
payable at time j, j = 1,2, ... , n
 St,j = the resale value of the technologically
improved equipment at the end of its jth period
 r = the discount factor
 Technological Improvements
 The objective is to determine that value of T, at
which replacement should take place, with the
new equipment
 The total discounted cost over n periods, with
replacement occurring at the end of Tth period
 C(T)=(Cp,1r1+Cp,2r2+Cp,3r3+...+Cp,Trn)+(Ct,1rT+1+
Ct,2rT+2+...+Ct,n-Trn)+ArT -(Sp,T rT + St,n-Trn)
T n -T
C(T) =  C p.i r i +  ct, j r T + j + Ar T - ( S p ,T r T + S t,n-T r n )
i=1 j=1
 Technological Improvements
 If the minimum cost occurs at T = n then
no replacement would take place and
the present equipment would be used for
the remaining n periods of operation.
 If the minimum values of C(T) occurs for
a value of T between 0 and n then the
replacement should occur with the
technologically improved equipment at
the end of the Tth period
Technological Improvements
 The total cost over a long period of time is:
 C(T,n) = costs over interval (0,T)+future
costs associated with new equipment over
interval (0,T)
 The costs over interval [0, T] i.e. C[0,T] are:
T
C[0,T] =  C p,i r S p,T r
i=1
-
i T
+ Ar
T
 Technological Improvements
The future costs, discounted to time T, can be
obtained using the previous equation as follows:
n

 Ct, j r r (A - S n )
j=1
+ n j

C(n) =
1 - rn

C(n) discounted to time zero is C(n).rT

n

 C t, j r r (A - S n )
+ n j

C (n) = r
* T i=1

1 - rn
Technological Improvements
 C(T,n) = C[0,T] + C*(n) is therefore the
model of the problem relating changing
over time to technologically improved
equipment, T, and economic life of new
equipment, n, to the total discounted
costs C(T,n).
Technological Improvements
 Solution Procedure:
 obtain data for Cp,i, Sp,i, Ct,j, & St,j as
described before
 determine the economic life, n*, of the
technologically improved equipment.
 obtain the total discounted cost C(T, n*),
for T = 0, 1, 2, ..., n*. (Note that n* = fixed
constant at this step).
 select the value of T (i.e. T* ) that
corresponds to the smallest C(T,n*).